AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings affirms the following rating on the Otay Water District,
California (Otay or the district):

--$37.8 million revenue certificates of participation (COPs), series
2007 (2007 water system project) at 'AA-'.

The Rating Outlook is Stable.

SECURITY

The COPs are secured by net revenues of the district's water system.

KEY RATING DRIVERS

SINGLE WATER SUPPLY SOURCE: The district purchases all of its potable
water supply from the San Diego County Water Authority (SDCWA). Its
reliance on imported water is a vulnerability.

POTENTIAL DESALINATION INVESTMENT: Otay is contemplating participation
in a desalination project. Water available from SDCWA would provide a
redundant back-up supply.

WATER SALES STABILIZING: Water sales stabilized in fiscals 2012 and 2013
after four years of declines. The drought in California and statewide
calls for conservation could soften sales although Otay does not
anticipate mandatory cutbacks from SDCWA given the investments in
drought-proof supplies and water storage.

RATE INCREASES IMPLEMENTED: The district has implemented sizable rate
increases since the recession began in 2008 to compensate for lower
connection fee revenues and lower sales. While additional increases are
anticipated, Otay's rates are competitive within the county.

CAPITAL NEEDS MODERATE: The utility's capital needs are moderate at $75
million over the next five years, a portion of which will be paid from
remaining 2010 bond proceeds. No additional debt is expected.

CHALLENGES IN SERVICE AREA: The district's service area is estimated at
74% of its developed population. While growth was strong in the early
2000s, there is uncertainty about when and to what magnitude growth will
resume.

RATING SENSITIVITIES

SHIFTS IN FINANCIAL MARGINS: The rating is sensitive to shifts in
fundamental credit characteristics, including the improving debt service
coverage. The Stable Outlook reflects Fitch's expectation that such
shifts are highly unlikely.

CREDIT PROFILE

GROWTH-SENSITIVE SERVICE AREA

The district serves a population of 211,000 in southeastern San Diego
County, including areas of the city of Chula Vista and a small portion
of the City of San Diego. Otay provides water to 48,962 connections and
an additional 704 recycled water customers. Otay also provides
wastewater service to a small area with 4,655 customers, but wastewater
net revenues are not pledged to bondholders.

Water connections previously grew 4% annually in the early part of the
last decade but recent five-year growth has averaged just 0.7% annually.
Recent connection growth has shown some momentum, with between 250-450
new meters in the last three fiscal years. Management's forecast
includes rapid growth, with between 550-950 new meters occurring in
fiscals 2015-2018. While the region is poised to accommodate new growth,
Fitch's rating analysis also considered the potential for more modest
growth at a level similar to the last few years.

RELIANCE ON IMPORTED WATER SUPPLY

Otay buys all of its water for potable water delivery from SDCWA. The
district has diversified delivery points and treatment plants in recent
years through multiple take-out points and contracts with other water
treatment providers to treat raw water deliveries from SDCWA. However,
single supply risks remain, similar to the rest of the region.

SDCWA continues to make investment to reduce its reliance on imported
water, which once made up all of its supply. It now purchases water from
Imperial Irrigation District (IID) that is ultimately delivered from the
Colorado River and will purchase water from the Poseidon desalination
plant once that project is complete in 2016. The desalination project
will result in a rate increase to customers (including the district)
given the higher project cost than imported water at this time. But the
desalination plant provides a drought-proof supply that would not be
subject to curtailment for hydrologic conditions.

Otay is in the planning stages of an agreement with Consolidated Water
on its construction of a large desalination plant located 25 miles south
of the U.S. Border in Mexico. The district anticipates that, if the
project is built, it will enter into a water purchase agreement for the
rights to around 20,000 acre-feet (af) annually. The district would
build a pipeline 3.5 miles from its system to the U.S. border where it
would take delivery of the water. Project development is still
preliminary but the district plans to have payment terms that require
payment only for actual water delivered. Also, the district does not
expect to take operational risk in the event of a plant outage.

STABLE WATER SALES; DROUGHT NOT A CONCERN

Water sales declined between fiscal 2007-2011, which was consistent with
other regional utilities as a result of the economic recession,
conservation investments and water rationing. The revenue impact of the
declines was mitigated somewhat by rate increases and lower water
purchase costs. Water sales have stabilized in recent years at 32,000 af
in fiscals 2011 and 2012 with an uptick in fiscal 2013 to 34,500 af, or
around 31 million gallon per day (mgd).

The fiscal 2014 budget conservatively assumed sales around 32,000 af
although actual sales are more in line with fiscal 2013 levels. Sales
may be softer in fiscal 2015 as a result of the voluntary 20%
conservation goal encouraged by the Governor as a result of the severe
drought. The district's conservative financial planning estimates of
water sales will mitigate the impact of softer sales.

Supply issues are not a concern at this time given SDCWA's access to
stored water at the Metropolitan Water District, its investment in the
IID supply and anticipated desalination water in 2016. SDCWA does not
anticipate curtailments until 2015 at the earliest. Otay also has very
efficient water delivery infrastructure with average system line breaks
and leaks per 100 line miles of only 13.6 in 2013 as compared to the
national average of 25-30 breaks. This limits water loss that must be
paid for without any sales to recover the cost.

IMPROVED FINANCIAL MARGINS

Financial performance at the district declined in fiscal years 2009-2012
as a result of a substantial decline in growth-related capacity fees,
declining water sales, higher debt service costs and increased water
purchase prices from SDCWA. Otay responded through rate increases
(averaging 9.2% annually over the past five years) and cost containment
efforts. Financial performance has improved although the district still
relies on capacity fees to a degree. Fitch calculated revenue bond debt
service coverage was 1.4x in fiscal 2013 (excluding wastewater revenues
that are not pledged). Combined coverage of revenue bonds and remaining
general obligation bonds was slightly lower at 1.3x.

Coverage levels are projected to continue to increase as additional rate
increases are implemented, with the district's goal to recover to 1.5x
debt service coverage excluding connection fees. Assuming growth resumes
to more historical levels, these additional revenues will be needed to
resume growth-related capital expansion. Cash reserves remain strong
with $65 million in unrestricted cash at the end of fiscal 2013, equal
to 339 days operating expenses.

For financial reporting purposes, the district consolidates the water
and sewer systems but only the water system net revenues are pledged to
bondholders. However, according to its continuing disclosure agreement,
the district provides investors with segment information for the balance
sheet and income statement for the water system.

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